One Strategy, Two Ways to Profit
09/20/2011 8:00 am EST
By modifying conventional wisdom about technical analysis, traders can get an edge over their competition and better identify low-risk, high-probability opportunities in all markets and time frames.
When it comes to trading the markets, at Online Trading Academy, we tend to think differently than conventional wisdom. One of the things I am always fascinated with is how we are taught to do certain things and how we learn, specifically when it comes to anything that has to do with competing.
In the United States, for example, we compete for jobs, money, better this, and better that. Have you ever realized that in the biggest democracy in history, our school systems don’t teach classes on how to compete?
In capitalism, there is typically a winner and a loser, unfortunately, yet people in this country are rarely taught in school how to compete or think differently. In fact, it’s the opposite. The natural education path of our school systems trains everyone to think the same way.
This is bad news for those who have the herd mentality and great news for those who focus on the simplicities and opportunities of competition. It all begins with thinking differently. If you bring the herd mentality mindset to competing in the trading markets, you will likely hand your account over to those who think differently and think about the markets properly.
The books that teach conventional technical analysis tend to teach it the same way, which offers little to no edge. Be careful taking the same action the masses do in the markets; they are not the ones who consistently profit.
This does not mean you should throw all your conventional information out the window. Instead, let me help show you some different ways to use some conventional tools.
Most people know all about assessing a trend. Typically, people look to see if the market in question is making higher highs and higher lows for uptrends, or lower highs and lower lows for downtrends. Others use moving averages to determine whether they are sloping up for uptrends or down for downtrends. These are the two most popular ways to assess a market’s trend.
Another way to assess trend is to look at the pivot lows in uptrends and pivot highs in downtrends. Let’s take the uptrend for our example. Looking back at recent prior data in any market on a price chart, it is easy to see what the current trend is.
What is equally important is to assess how healthy the current trend is and when and where it may end. One way to do this is to measure the distance between the lows of the pivots that make up the uptrend.
Notice the uptrend in the chart below; the distance between the pullbacks (pivot lows) is decreasing as the trend moves higher. This means the trend is becoming weak and is likely to end soon. The logic behind this is that a strong trending market does not pull back often. If it does, it is not a strong trending market anymore.
Keeping with our constant supply and demand theme, remember that a trend on any time frame is really a supply and demand imbalance moving back into a price level of temporary balance. This is a larger time frame chart, but the assessment can be done in any market and any time frame.
NEXT: How to Trade Wisely with Moving Averages|pagebreak|
Moving averages (which I don’t use) are another common ingredient of conventional technical analysis (which I don’t use). The two ways most traders use them are:
- To determine trend by looking at the slope of the moving average
- To time an entry (buy or sell signal) into a position or an exit out of a position.
This technique is very flawed in that moving averages, by definition, will lag price; they have to. Adding any tool that lags price to the execution portion of your trading plan adds risk and decreases profit margin, and we don’t want that.
Again, instead of thinking the same way as your competition, let’s take a slightly different view of moving averages in a way that may help us gain an edge over our competition.
Notice in the chart example where I have circled the moving average cross. Moving averages cross because there has been a relatively strong move in price. At the origin of a strong move in price, demand and supply are out of balance. Price levels where demand and supply are out of balance is where we typically find low-risk, high-reward, and high-probability trading opportunities.
So, try identifying moving average crosses in the past and let that lead you to investigate the price action in that area. Chances are high that you will find a key demand or supply level there.
In other words, when you find a moving average cross above or below current price, look slightly to the left of the cross and investigate the price action, as that is where the origin of the strong move likely was, which means there is a demand/supply imbalance.
These are two examples of how you can apply conventional technical analysis slightly differently than your competition in hopes of attaining an edge. While I don’t use these two examples in my own trading, I make sure that my tools and strategy are very different than that of my competition, almost opposite, but most importantly, "reality-based."
This is the only way to be consistently profitable speculating in the markets. The purpose of today’s piece was to encourage you to think differently and not to follow the herd and their very flawed thought process.
By Sam Seiden, instructor, Online Trading Academy